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S&P Says Too Big To Fail Is Still Here But Might Not Be Sometime Soon

Standard and Poor's took down JPMorgan Chase's ratings outlook from stable to negative. And the government's implicit support for banks might be on the way out.

Posted on June 11, 2013, at 3:19 p.m. ET

Standard and Poor's, one of the three major agencies that rate the credit worthiness of companies, seems to believe that the age of too big to fail banks is coming to an end. Well, not immediately, but maybe sometime soon, which is sort of like progress.

In a report issued Tuesday entitled, "Standard & Poor's Factors Evolving Nature Of Government Support Into Its Outlooks On Eight U.S. Bank Holding Companies," the much beleaguered and criticized firm may be close to solidifying a consensus that the Obama administration's efforts to end too big to fail are bearing fruit.

Though S&P only took down one bank holding company's rating outlook from stable to negative – JPMorgan Chase, which still has an "A" rating – it suggested that the Federal Deposit Insurance Corporation, which is responsible for dealing with normal, non systemic bank failures, has made real progress in taking Dodd-Frank's provisions to eliminate taxpayer bailouts of big banks. Basically, S&P is saying that there is now a real expectation that bank executives, lenders, and shareholders won't be able to count on government support in a crisis.

"It is becoming increasingly clear that holding company creditors may not receive extraordinary government support in a crisis" S&P said in a statement

S&P's release points to progress made by the FDIC is specifying how they would operate the "Orderly Liquidation Authority," a provision in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 that allows the FDIC to takeover, operate, and eventually wind-down a systemically important bank while imposing losses on bank creditors. This is where the opinion of ratings agencies might really matter: their specialty is in evaluating the riskiness of corporate debt, and if the FDIC's resolution authority plans are taken seriously by the market, then the riskiness of the debt issued by the largest banks should go up, meaning their ratings would be downgraded.

Eight of the largest U.S. banks receive what S&P calls "ratings uplift," a boost to their credit ratings based on the expectation of government support in a crisis. While the uplift remains, all eight systemically important bank holding companies have a negative outlook which "reflect[s] the possibility that we may no longer incorporate extraordinary government support into the ratings…because of the evolving resolution framework," said S&P.

But no matter how many plans the FDIC puts out and how much senior government officials insist that banks won't receive support in a crisis, everyone from bank executives to bank lenders to shareholders needs to believe it for Dodd-Frank to actually restrain how banks conduct themselves so that bailouts aren't needed in the future.

There is some indication that S&P may be following a consensus. The New York Fed released research showing that the market for credit default swaps, which are contracts that pay off when companies default on their debt, had taken into account "the view that senior bondholders run a higher risk that they'll need to share in the costs of bank resolution."

Sheila Bair, the former head of the FDIC and one of the most prominent supporters of more aggressive bank regulation, wrote an article for Fortune in April arguing that the FDIC was much closer to being able to shut down a large bank in a financial crisis. Mary Miller, the Treasury undersecretary for domestic finance, said in a speech that "no financial institution, regardless of its size, will be bailed out by taxpayers again." Her remarks came under fire from Simon Johnson, the former chief economist of the International Monetary Fund, who wrote that her speech was "completely unconvincing on the substance of the points that she is trying to make. Dodd-Frank alone will not end too big to fail."

"The credit rating agencies are are really good at reflecting a certain kind of conventional wisdom," said Mike Konczal, a fellow at the liberal Roosevelt Institute, "When they do move it will be the consensus opinion."